Looking at the trends of stock analysis and research, people are nowadays starting to take up the responsibility themselves because there’s always a cloud of uncertainty encompassing the credibility of most analysts. Becoming your own stock analyst doesn’t always have a certain chunk of rationale to it. Any investor who’s unwilling to depend on another individual should take up learning to think like stock analysts. But how, exactly?
The concept of stock research, or what investors call nowadays, fundamental analysis, may be compared to the decision of which vehicle to buy for yourself. Technical configurations are a big deal, and you can make a purchase based completely on them. But it’s imperative to also keep in mind the feel your car gives during the test drive. Even details like the charisma and reliability of the manufacturer can and should be taken into consideration.
Quite similarly, there are a plethora of factors that contribute to the appropriate evaluation of a stock – financials of a company, its leadership team, and the competition which are all equally decisive in your research. Before we start articulating the four steps for beginners in stock evaluation, it’s vital to reinstate that stocks are investments made in the long run. They’re risky, to say the least, and it’s best if the money you’re putting in isn’t of utmost necessity for you in a few years.
1) Secure Materials Needed for Your Stock Research
Kick-off the process by taking the financials of your company and analyzing them. But first, you’ll need a couple of documents that every company needs to fill out from the U.S. Securities and Exchange Commission. The first is ‘Form 10-K’, a yearly report of the audited major financial statements, which contains the balance sheet of a company, its income sources, revenues, and expenditures. Then there’s ‘Form 10-Q’, a quarterly performance update. Open a brokerage account to gather more information about finances, and set up a comparison between two companies to decide where your investment would be more fruitful. Elaborate quantitative research like this is fundamental to start with. To know more, check out Stocks Reviewed blog.
2) Narrow Down Areas of Focus
After you’re done reviewing your financials, you’re bound to stumble upon a heavy load of numbers here and there. Carefully narrow down a few things to get a clearer internal picture of a company:
Revenue: On the income statement, this is the topmost thing you’ll notice (revenue is at times called ‘top line’). Simply put, revenue is the money taken in by a company within a specific time. You can break down revenue into two classes: operating revenue, which originates from the core business of a company, and non-operating revenue, which comes from a temporary business dealing like an asset sale. As you can tell, operating revenue is far more significant to consider when you are analyzing a company.
Net Income: You get net income by subtracting all taxes and operating expenses from the revenue generated by the company. If you consider revenue to represent your salary, then net income is the money left after you’ve paid off your bills, taxes, and living costs. It’s a ‘bottom line’ figure, often put at the bottom of the income statement.
EPS: Earnings per share is calculated by dividing earnings by the available number of shares. EPS display profitability per unit share, which makes the comparison with other companies clearer. EPS is measured and considered by investors instead of just earnings because the latter fails to depict how the company utilizes its capital.
P/E: The result conveys the amount investors want to pay to receive a dollar of the earnings of the company. Find Price-Earnings ratio (P/E) by dividing the present stock price of a company by its earnings per share. Forward P/E is calculated by taking the predicted earnings from Wall Street experts into consideration.
ROE & ROA: Return on equity (ROE) is the percentage of profit made by the company per dollar shareholder investment. On the other hand, return on assets (ROA) is the percentage of profit made per dollar of the company’s assets. Both ROE and ROA paint a picture of the company’s profitability, with numbers derived from its annual net income.
3) Qualitative Research is Equally Important
After a thorough report of the financials of a company through quantitative research, don’t forget to emphasize qualitative research, which helps you understand all the prospects of the company really well.
Way of Generating Income: This may be straight forward or may not be. Whatever it is, a primary rule is to invest in a company you completely understand, starting from how it makes money.
Presence of Competitive Advantages: Every brand has a story to tell that sets it apart from its competitors. Research and find out what it is that makes the company you want to invest in difficult to overthrow.
Assess the Risks: Every company has developments in prospect which could expose its stakeholders to risk. They can range from the invalidation of a significant patent to the rise of a powerful competitor in the market. Get insight into these roadblocks and assess them beforehand.
Quality of the Management Team: It’s the leader of a company that’s supposed to wave his wand and lead the proceedings from the very front. Analyze how the leaders are. Start off by reading into the transcripts of meetings, annual reports, and also go through the company’s board of directors and shareholder representatives if possible. Try picking a company with enough liberal thinkers who can evaluate the management decisions from a neutral point of view.
4) Pull Off Conclusions to Your Research by Putting Context
So far, we’ve discussed several metrics to evaluate the overall financials of a company and assess the in-depth valuation of its stock. But even all of this put together don’t quite make a point yet.
You need context to establish why the company deserves to be noticed by enthusiasts like you. To have a worthy narrative, accumulate and assess statistics and historical numbers for long-term context. This gives you the opportunity of judging the perseverance and determination during rigid scenarios and challenges and how the company adds convincing value to its shareholders. Compare these with average data of the relevant industry, get a bigger picture painted, and then decide!
This is how you choose stocks that fit your portfolio perfectly. These can easily be tracked in the comfort of your home, and you’ll be able to understand the schemes, where you’ll be putting your money in, top to bottom. So sit back after making the investment and let the money roll in.